Public companies have welcomed the United States District Court for the District of Columbia’s decision on July 2, 2013 to vacate and remand the Securities and Exchange Commission’s (SEC) resource extraction rule (Rule 13q-1).1 This rule would have required public companies that qualified as a “resource extraction issuer” to publicly disclose in an annual report on Form SD payments made to a foreign government or the U.S. federal government in connection with the commercial development of oil, natural gas, or minerals. Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) added Section 13(q) to the Securities Exchange Act of 1934, as amended (Exchange Act), which instructed the SEC to issue final rules that would require payment disclosure by resource extraction issuers. The SEC adopted Exchange Act Rule 13q-1 and Item 2.01 of Form SD in August 2012 to implement Section 13(q)’s disclosure requirements.2

Noting the rule’s “substantial” and “grave” deficiencies, the court vacated and remanded the rule to the SEC for further proceedings. The SEC has yet to indicate whether it intends to appeal the decision. Although the decision provides relief for public companies that were preparing to comply with the rule that would have required disclosure for fiscal years ending after September 30, 2013, the relief is likely only temporary. The SEC is still required by Dodd-Frank to adopt a payment disclosure rule, and the SEC may undertake new rulemaking to address the court’s concerns. Issuers that were subject to the invalidated rule should continue to prepare for implementation of an SEC rule required under Dodd-Frank, even though any new rulemaking will likely be somewhat different from the invalidated rule.

Opinion

Plaintiffs’ claims. After the SEC adopted the rule, four business groups filed suit challenging the rule and alleging that:

Section 13(q) and Rule 13q-1 compel speech in violation of the First Amendment;

the SEC erroneously read the statute as requiring public disclosure of the full annual reports;

the SEC was arbitrary and capricious in declining to grant an exemption for countries that prohibit disclosure;

the SEC’s cost-benefit analysis was flawed;

the SEC was required to solicit additional comments before relying on a particular set of data; and

the SEC arbitrarily declined to define the term “project.”

In reaching its decision to vacate the rule, the court did not address the plaintiffs’ First Amendment challenge or most of their other arguments, but rather focused on “two substantial errors:”

the SEC misread the statute to mandate public disclosure of the full annual reports; and

the SEC’s decision to deny any exemption was arbitrary and capricious.

Public disclosure of full annual reports not mandated by statute. The court held the rule to be invalid because the rule’s public disclosure requirement was based not on the SEC's own judgment, but rather on the SEC's erroneous view that it was required by the statute. Although Exchange Act Section 13(q) provides that the SEC’s rule must require disclosure of commercial development payments “in an annual report” of the resource extraction issuer, the statute “says nothing about public filing of these reports.” As the court noted, “[t]he statute speaks of ‘disclosure’ and ‘an annual report,’ not ‘public disclosure’ and not a ‘publicly filed annual report.’” The court also noted that a separate subsection of the rule that expressly requires public disclosure by the SEC of a compilation of the information submitted in the annual reports, but only to the extent practicable, “eliminates any inference that Congress relied on…the disclosure provision, to establish the information’s public availability.” In conclusion, the court noted that “[i]f this is Congress’s way of unambiguously dictating that reports must be publicly filed, it is a peculiar one indeed.”

Denial of any exemption was arbitrary and capricious. Despite estimating that costs associated with the host country laws of four countries that commentators suggested prohibit public disclosure of payment information could be in the billions of dollars for affected issuers, the SEC declined to adopt an exemption for countries prohibiting disclosure. As a result, the court held that the SEC made another “serious error” that independently invalidates the rule. The court noted that “given the proportion of the burdens on competition and investors associated with this single decision, a fuller analysis was warranted.” Moreover, the court noted that the SEC “abdicated its statutory responsibility to investors” in denying any exemption because it was “[a]verse to sacrificing any of the section 13(q) aims no matter the cost.”

What’s Next?

With the rule invalidated, the SEC can appeal the court’s decision or undertake new rulemaking that takes into consideration the court’s concerns. For example, the SEC could draft new rules that (1) allow confidential submission of the payment information and (2) contain an exemption for countries that prohibit public disclosure of payment information (Angola, Cameroon, China and Qatar were cited) or any country that prohibits such disclosure as of a certain date. However, merely addressing these two matters could leave any revised rule subject to further challenges because the court did not address plaintiffs’ other claims. As a result, if the SEC undertakes new rulemaking, it would be prudent for the SEC to conduct a more fulsome cost-benefit analysis and provide more justification for the new rule, as well as appear more responsive to commentators’ concerns. Based on the court’s comments regarding the SEC’s responsiveness to issuers’ concerns, affected issuers should consider providing comments to any new rule making by the SEC.

Regardless of how the SEC proceeds in response to the decision, it appears likely that the deadline for reporting payments will be delayed. The SEC is still mandated by Dodd-Frank to adopt a rule requiring disclosure of the payment information. Accordingly, issuers should expect that some SEC rule will be implemented and continue to prepare for implementation of the rule (e.g., by continuing to collect the payment information required by the invalidated rule and establishing disclosure controls and procedures to collect such information), even though any new rulemaking will likely be somewhat different from the invalidated rule.

The court is also handling the challenge to the SEC’s conflict minerals rule adopted pursuant to Dodd-Frank. It remains unclear at this time whether the court’s decision to invalidate the payment disclosure rule portends a similar result in the conflict minerals rule case. With the court holding oral arguments on July 1, 2013, a decision is expected soon.

David has an extensive corporate and securities law practice emphasizing transactional and governance matters. His corporate finance practice includes representing both issuers and investment banks in initial public offerings and other public and private equity and debt offerings. He also advises companies, special committees and financial advisors concerning merger and acquisition transactions (both public and private). In addition, David regularly counsels public clients regarding compliance with periodic reporting, proxy solicitation, corporate governance matters and other...

John is a Partner and practices in the corporate and securities area. He has extensive experience representing issuers and underwriters in public offerings and private placements, guiding public companies through securities law compliance issues, structuring and negotiating mergers and acquisitions, and organizing and generally advising corporations, limited liability companies, partnerships and other ventures. He has also been involved in litigation matters involving mergers and acquisitions, takeovers and fiduciary duty disputes. John’s clients have included both publicly traded...

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